As far as investments are concerned, your home is one of the largest and most important investments you can make. With that in mind, it is important to know how you can best leverage your home investment in a way that makes the most financial sense.
Refinancing your mortgage can be one of the best ways to get the most out of your current home loan and can help you leverage your current investment. When refinancing an existing home loan, borrowers can either lower their monthly payment, shorten their loan term, or receive cash from the equity they have in their home.
With so many different options available to those who decide to refinance, this article can give you a good idea of what refinancing looks like and help you decide if it’s right for you.
What is Refinancing?
Mortgage refinancing refers to the process of replacing your existing home loan for a new one. During refinancing, the old loan is paid off by the new one leaving the borrower with just one single loan with one monthly payment.
In most cases, borrowers who choose to refinance do so for two primary reasons. The first is that they want to access cash from the equity they’ve built up over the years of ownership. The other main motivation for refinancing is that they want to replace the current rate or terms of their existing mortgage– usually for a lower rate or shorter loan duration.
Aside from those two main reasons, the refinancing process can also be used to remove another person from the mortgage, which often happens after a divorce.
How Does Refinancing Work?
Typically, the refinancing process is less tedious than the home buying process, even though it includes many of the same procedures. While it can be difficult to assess how long a refinance will take, the usual timeline is anywhere between 30 and 45 days. Here are the main steps that go into the refinancing process.
Step 1: Apply to Refinance Your Loan
The first step of refinancing a mortgage is to apply for a refinance with your lender. When applying, your lender will ask for most of the information you already gave them when you bought the home.
Lenders will review your income, assets, debt, and credit score to assess whether or not you meet the refinancing requirements and will be able to pay back the entire loan. Typically, a lender will ask for these documents:
- Your two most recent pay stubs
- Two most recent W-2s
- Two most recent bank statements
These basic documents will also be requested from your spouse if you’re married. Those who are self-employed can expect to provide more income documentation for the lender to better analyze their risks.
One other important to note is that you aren’t obligated to refinance with your current lender. Those who choose a new lender will have them pay off the current loan, which will effectively end the relationship with the old lender.
Knowing this, it is critical that you shop around to compare different lenders’ current rates. You should also research how satisfied previous clients were with their services, as well as their current availability.
Step 2: Lock in an Interest Rate
After approval, you may be provided with the option to lock in your interest rate before the loan closes. Rate locks usually take anywhere from 15-60 days.
The length of the rate lock period will typically depend on a variety of factors such as your location, loan type, and individual lender. Loans that don’t close before the end of the lock period might need to be extended, which could cost additional money.
Aside from locking in a rate, lenders may also give you the option of floating your rate. By floating your rate, you are choosing to forgo locking in a rate before the loan closing. Doing this can give you a chance of ending up with a lower rate at closing; however, it also puts you in danger of having to pay a higher interest rate than the proposed lock rate when the time comes.
In some cases, lenders also offer a float-down option. But if you’re pleased with your locked rate, it is usually recommended to proceed with that so that you don’t have to risk paying a higher rate when the loan closes.
Step 3: Underwriting
Having gone through the preliminary steps of applying for refinancing as well as locking in your interest rate, the next step in the refinancing process is underwriting. Once the application has been submitted, the lender will begin the process of verifying that all the documentation submitted is accurate.
Lenders will review the details of the property in question by taking a look at when you bought your home in addition to the home’s appraised value. The refinance appraisal is critical in the refinancing process because it determines what options are available to you, the borrower.
Those looking to get cash from their refinance will depend on the home’s value being high enough to get the cash they need. Borrowers looking to lower their monthly payments will have to have enough equity in their homes to rid themselves of private mortgage insurance (PMI).
The appraisal will also need to be high enough for borrowers to be eligible for other different loan options. With that in mind, the appraisal process is a crucial determining factor in what options will be available to the borrower through refinancing.
Step 4: Have Your Home Appraised
The home appraisal must be done before a borrower refinances. Appraisals will be ordered by the lender. Once set up, an appraiser will visit the property and give an estimate of the home’s value. Making a good first impression on the appraiser is crucial if you’re looking for your home to be appraised for top dollar.
Before the appraiser comes by, make sure that your home is clean and that any minor repairs have been taken care of. You might also want to create a list of upgrades that you’ve made to the home so that appraiser is aware of the improvements that have been made to the property. If the home’s value is equal to or exceeds the loan amount you’re looking to refinance, then the underwriting process will be complete.
Doing these things will ensure that you have the best chance of your house being appraised for top dollar, but what should you do if the estimate comes back lower than you expected? In this scenario, borrowers can either decrease the amount of money they wish to refinance or cancel their refinance application altogether.
Step 5: Closing on Your New Loan
After the underwriting and home appraisal processes are complete, the next step is closing on your new refinanced loan. Three days before closing, you can expect a closing disclosure document that will provide you with a detailed overview of the specifics of your loan.
In most cases, the closing for a refinance is much quicker than the closing of a home purchase. Those who attend the home closing are usually the individuals who are on the loan and title, as well as a representative from the lender or title company.
At the closing, you can expect to go over the details of the loan. This is the time where you’ll pay any additional closing costs that aren’t included in the loan itself. Additionally, you can also expect to be paid by the lender if they owe you any money in the scenario of a cash-out refinance.
These funds will be received after closing. Once all the documents have been signed, you can consider the loan closed. However, there is a 3-day grace period after closing that allows a borrower to back out of the refinance.
4 Reasons to Refinance Your Mortgage
Having gone over how the general process of refinancing works, you may be wondering why you would want to refinance your existing home loan. Here are some of the potential benefits of a refinance.
1. Shorten or Lengthen Your Loan Term
Many borrowers choose to refinance to shorten their loan term. Shortening the duration of a loan can save you a lot of money in interest down the road.
If you’re someone who started with a 30-year loan and can now afford a higher payment, you might be able to take advantage of refinancing to a 15-year term at a lower interest rate. While this could increase your monthly payment, you will ultimately save money in interest if you decide to pay off the loan within a shorter period.
Conversely, borrowers looking to lower their monthly payments have the option of extending the loan duration through a refinance. This will allow you to pay less money every month but more money in interest over the loan term.
2. Lower Your Interest Rate
Because interest rates are constantly changing, those who are looking to take advantage of the current low-interest-rate environment might want to refinance at a lower rate than when they first purchased the home.
Locking in a refinanced loan at a lower interest rate could lower your monthly payment while saving you a lot of money in interest paid over time.
3. Change Your Type of Loan
Not all loans are created equal, and there could be numerous reasons why you would be interested in changing your loan type.
For example, let’s say you originally were approved for an adjustable-rate mortgage (ARM) to have a lower interest payment initially. After some time, you realize that rates are low and would like to lock in a low fixed rate.
This could be a good reason to choose to refinance. Another common change in loan type is switching from an FHA loan to a conventional one so that you can avoid paying private mortgage insurance.
4. Cash Out Your Equity
If you’re interested in a cash-out to refinance, you can use your current home equity to borrow more than you owe on your home while receiving the difference of that value in cash.
Homes that have increased in value are many times eligible for a cash-out refinance to get cash for upgrades and renovations. The cash can also be used to consolidate debt or take care of other expenses. Taking advantage of cash refinance allows borrowers to get access to cash at a much lower interest rate than most typical personal loans.
The Cost of Refinancing
The total cost of a refinance will largely depend on a multitude of factors. It can many times come down to your lender as well as your home’s value.
In general, you can expect to pay two to three percent of the total value of your loan. But in many cases, borrowers might not have to pay that cost out of pocket. There are no closing cost refinancing options available that can help you forgo having to pay anything out of pocket.
Takeaway
Many considerations need to be made when deciding if it makes sense to refinance or not. Some of the most important factors to consider are market trends, personal financial health, and current interest rates.
Suppose you’re looking to take advantage of a lower fixed interest rate or would like to shorten or extend the duration of your loan to either pay less interest or have a lower monthly payment. Refinancing could be an excellent option.
Additionally, those looking to get access to cash at a low-interest rate can greatly benefit from refinancing if they need the money to consolidate other debts or pay for a major expense.
Having gone over the overall process of refinancing, as well as how it can help borrowers accomplish their financial goals, it has become clear that refinancing an existing home loan is a powerful way to leverage one of the most important investments of your life.
